Money in an inflation-linked bond won’t lose in inflation-adjusted terms
Ten years ago it was taken pretty much for granted across the market that if you wanted your money to grow faster than inflation you needed to be in the equity markets. But the dismal returns of the past decade have ravaged the purchasing power of all too many stock-market investors. And with the best interest rates on the market at around 3% and inflation running at well over 5%, anyone keeping their wealth in cash will be aware of the need to reduce the disparity. That’s why thousands of us poured as much money as we could into the NS&I index-linked bond last year and why a collective groan went up when it was withdrawn. But that groan didn’t go unnoticed by the UK’s corporate sector: our big companies have now taken to launching high-yielding and inflation-linked bonds of their own directly to retail investors.
John Lewis tested the water early in 2011 with a bond sold directly to their account-card holders and paying 6.5% with a five-year term. Then came a few from smaller issuers. And finally, towards the end of last year, Tesco stepped up to the plate with every investor’s dream: a bond that pays 1% above the Retail Prices Index (RPI) over eight years and can be traded on the stock market. This was so popular it seems likely that many similar bonds will hit the market in 2012.
Should you buy them? The first thing to note is that no bond of this kind can ever be as good as the ones from NS&I: nothing else is tax free (although most bonds can be held in an ISA) and nothing else is fully backed by the Government. All private companies can go bust. But if you are prepared to take that risk, some returns on offer from UK company bonds are pretty good, inflation-linked or not.
The consensus from economists is that inflation will fall all the way through 2012. If they are right, holding inflation-linked bonds might seem silly: if RPI comes down to, say, 2% you’d be better off with a fixed-rate deposit account at, say, 4% for five years, rather than a company bond of RPI plus 1%. But what if the economists are wrong? At least money in an inflation-linked bond won’t lose in inflation-adjusted terms, whatever happens to prices. That makes these bonds a pretty good hedge. And as for the bonds offering non-inflation-linked returns? If John Lewis comes up with another paying 6.5%, I’ll be buying it. You don’t get that kind of rate backed by that kind of name very often.
Merryn Somerset-Webb's views are personal. Investors should seek professional advice.
This article was originally published in the February 2012 issue of Saga Magazine.